Sales compensation plans: the basics

In this guide we try to cover the basic concepts in sales compensation that might not be familiar to managers or business owners who come from a non-sales background.

Pay: It’s one of the most important factors – if not THE most important factor – in any job. This is true for both the employee, who wants to be financially rewarded for the work they do, and for the business itself. After all, human performance has always been, and always will be, one of the biggest variables affecting overall business success, so employee motivation must continue to be a primary consideration.

However, for businesses, there is more to creating a suitable and satisfactory compensation package than simply employee motivation, especially when it comes to sales. If there wasn’t, the whole thing would be much simpler! As well as motivating sales representatives and encouraging them to hit their targets, a good compensation package should also allow a business to achieve their goals, while simultaneously maintaining financial corporate stability. It sounds easier said than done, right?

The truth is that it can be tricky to find the right balance, but there is good news. Unlike the situation across many other sectors, there is a reasonable amount of flexibility in sales. This means it’s often possible to use some less traditional compensation models, or even combine a variety of models, to find a solution that not only works for your sales reps and account managers, but also for your business.

There are many different types of compensation package; more than we could possibly cover in just a simple basic guide! For example, there’s the territory volume-based model, the profit margin plan, and the quota-based bonus method, which is typically most popular within pharmaceuticals, medical devices, and technology, according to research by the Harvard Business School. However, for most businesses employing sales reps or sales teams, there are are generally two ‘standard’ compensation packages which are most commonly preferred: a fixed monthly salary, and performance-based commission.

Fixed Salary

A fixed salary probably isn’t the most widely adopted of compensation packages in sales, but it’s certainly not unheard of, and it definitely has its place. Under this model, sales reps are paid a fixed, consistent monthly salary in exactly the same way that any other member of staff, such as IT staff and HR staff, are paid. This salary can be standalone, or paired with additional benefits, such as healthcare, insurance, or employer pension contributions for example. What you offer is completely up to you.

One of the main benefits of the fixed salary model is that it highlights your business as an attractive place to work, removing from the position the sort of financial uncertainty which is pretty common in sales. But there are downsides, too. Firstly, sales incentive is lost. There is no reason — other than passion for the task at hand — for sales reps to go above and beyond; they are paid regardless of their performance, which can prove to be detrimental to a business, especially those within a highly competitive market. Additionally, this model assumes that all products, within all markets, are of equal value to the company.

It could be argued that a fixed salary compensation model best suits small, group-based sales teams with combined input from all parties, as it ensures that all efforts are rewarded, even in cases where a specific individual isn’t directly a part of a deal closure. This method can also prove to be beneficial for teams that are not exclusively sales based, but also undertake many other duties within the workplace. This makes sure that your employees are rewarded for their work with a consistent, predictable income.

Commission

There are two types of commission-based compensation model to consider: commission only, and a combined commission + salary option. With commission only, the benefit is very strong, very intense motivation for sales reps. It provides incentive for them to learn new skills, try new techniques, and better themselves by grabbing professional development opportunities in order to be the best at what they do. After all, if they’re not good at their job, and they’re not hitting targets, they’re not getting paid.

The downside to commission only, of course, is that it’s not exactly a highly desirable model for sales reps, and may affect how your business is viewed by those within the industry. There is a lot of financial uncertainty here, which won’t appeal to risk averse candidates. However, there is actually an upside to this: those that are attracted to sales positions within your company will likely be highly motivated, highly sought after individuals who are confident in their abilities to market and sell your products. Despite this, only a small amount of companies using a commission-based compensation model use commission exclusively. A combined approach is arguably more common.

While there is no hard and fast rule about combining salary and commission, a 60% base salary and 40% variable seems to be the norm. The advantage is that sales reps are provided with the financial security of a monthly salary, even in volatile markets and at times of low sales. The disadvantage is that there needs to be a great deal of input from the business, to ensure that strict metrics are in place to track performance and justify variable pay to sales reps.

One consideration is the metrics that will be used to determine success. Units sold? Products sold? Markets sold to? Overall contract value? Number of new accounts? Customer satisfaction? Meeting of personal goals? A further consideration, regardless of which commission model is used, is whether a commission cap will be implemented.

Which Is Better?

The answer to this question really depends on who you ask! A 2009 Journal of Business and Industrial Marketing report, for example, claims that fixed salary employees perform better than commission employees, and at the very least the base salary should be much greater than the variable portion. In contrast, other reports claim that the more responsive a business is to sales efforts (i.e. the more an employee is recognised and rewarded individually), the greater the efforts.

One size very clearly does not fit all! Not only is it important to identify a compensation model that suits your business, it’s also important to try to be flexible in your approach, making sure not to overlook the fact that a single model may not be wholly applicable across your entire sales team. Consider, for example, the case of key account managers; those with long-standing relationships with a select few long term clients. A commission-based model using new account metrics, or new market metrics, to determine overall performance simply wouldn’t work, and could actively have a negative impact upon profits.

Variable pay is a complex area; much more so than fixed pay. However, it’s also something that can be a significant motivational tool for the right people, at the right time. Remember, there is no right or wrong way to implement a compensation model, but there are some models that seem to suit some teams better than others. Be sure to consider this when making your choice.